Income Redistribution Makes Our Children Poorer

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Democrats love to claim that their income redistribution policies are economic stimulus programs. They believe that since poorer people spend all or almost all of their money while the rich save some of their money, the economy will be boosted by taking money from the rich and giving it to the poor. This is not only a fundamental misunderstanding of economics, but it will make our country poorer in the long run.

The most basic equation in macroeconomics will explain why the Democrats' income redistribution doesn't boost the economy. The size of an economy is measured by the gross domestic product (GDP), which equals both the value of all goods and services produced in an economy in a year and the value of aggregate income in the same economy (since those two values must be equal). In the basic equation as taught in every introductory economics course, GDP = C + I + G + (X-M), which means that GDP is the sum of consumption spending, investment spending, government purchases of goods and services, and net exports (exports minus imports).

Democrats believe that redistributing income from richer to poorer people will increase consumption (C) because those getting the welfare payments, unemployment checks, or other transfer payments will spend it all while the rich would have saved some. Democrats are correct that income redistribution policies can increase consumption, but they are missing an offsetting effect.

A second truism in macroeconomics is that saving equals investment. This has to be true because the only way to fund an investment, such as building a new factory, is for somebody to first save the money. The savings and investment can be done by different people because banks can turn one person's savings into another person's loan, thereby turning savings into investment.

This second truism is the flaw in the Democrats' social/economic theory. Their income redistribution boosts consumption by reducing saving. This means investment must fall by an amount equal to the increase in consumption, leaving GDP unchanged. This should be obvious to anyone with even the most basic economic knowledge since GDP is also equal to the total of everybody's income. Redistributing income does not increase income, it only moves it around. Rearranging your furniture does not make a brand new sofa materialize in your living room; it just changes what furniture is where.

Hopefully what I just explained has shown readers the fallacy of the idea that income redistribution can lead to a boost for the economy. Now, let's turn our attention to my claim that it will make our country poorer in the long run.

Robert Solow won a Nobel Prize in economics for his theories about economic growth. A key result derived from the Solow growth model is the Golden Rule Savings Rate which showed how increasing a low saving rate makes a country richer in the long run (the term, Golden Rule, was coined by Edmund Phelps, another Nobel Prize winner).

In the short run, more savings means less consumption so people have less stuff to enjoy right now. However, in the long run more savings means more investment which means more goods can be produced by each worker (thanks to all those investments in capital goods). A little sacrifice by one generation leads to gains for future generations because consumption goods are consumed, then gone, while investment leads to long-lasting capital that can be used to produce goods and services for many years.

A country with a higher savings rate will, in the long run, be a society with both a higher income level and a higher consumption level. That is, that even though more is being saved, people still end up with more stuff (consumption). By reducing saving now we are costing ourselves both consumption and wealth down the road. In exchange for votes today, politicians are sacrificing part of our future.

The supposed benefits of income redistribution need to be refuted. Some people may support income redistribution on philosophical grounds (John Rawls would approve) if they believe it is just about taking money away from the rich to give money or stuff to the poor (or middle class). However, if people realize that income redistribution carries an additional cost that makes society as a whole poorer in the long run, many of them may reconsider their support for such policies.

Taking from the rich to give to the poor now means that there will be less available for such redistributive schemes in the future. Robin Hood-style government is not sustainable because it reduces the future income available to be redistributed. If the Democrats aren't careful, they will put themselves out of business by making us all poor.

Jeffrey Dorfman is a professor of economics at the University of Georgia, and the author of the e-book, Ending the Era of the Free Lunch

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